Federal Reserve to Expand Annual Capital Reviews to 35 Largest U.S. Banks

The Federal Reserve announced that they will expand their capital planning program to include the largest 35 banks in order to have a adequate buffer during an economic crisis. This will include any bank that has at least $50 billion is assets.

The Federal Reserve said it will expand a capital-planning program to the 35 largest U.S. banks to ensure they have an adequate buffer in an economic crisis.

Bank holding companies with at least $50 billion in assets will be required to adopt “robust, forward-looking capital planning processes that account for their unique risks,” the Fed said today in a statement in Washington.

Banks would be required to submit plans to raise dividends or repurchase stock as part of the reviews, to begin early next year, the Fed said. Firms whose plans are rejected would have to get approval before distributing capital.

The reviews are part of a broader effort, which includes the Dodd-Frank Act overhauling financial regulation, to tighten supervision of financial firms and reduce the risk of another crisis. In March, the 19 largest banks, such as Wells Fargo & Co. (WFC) and JPMorgan Chase & Co. (JPM), completed capital reviews that allowed many of them to boost dividends or buy back shares.

“During the years leading up to the recent financial crisis, many bank holding companies made significant distributions of capital, in the form of stock repurchases and dividends, without due consideration of the effects that a prolonged economic downturn could have on their capital adequacy,” the Fed said in its proposed rule.

The initiative may force banks to hold additional capital and reduce profitability measured by return on equity, said Bert Ely, an industry consultant based in Alexandria, Virginia.

“In wanting higher capital standards, they really want the bigger banks to be bulletproof,” he said. “There will be tremendous pressure to downsize” or have “financial engineers to come up with new forms of shadow banking” by moving activities outside commercial banks.

Some investors welcomed the tougher supervision, saying it’s long overdue.

“This amount of oversight is something that has been lacking in the corporate board room in most banks,” said Joel Conn, president of Lakeshore Capital LLC in Birmingham, Alabama. “For smaller banks, it is pretty clear that their capital ratios were not adequate for a major economic downturn.”

Bank Shares

The KBW Bank Index, which tracks 24 U.S. financial institutions, extended losses after the Fed announcement, then rallied after CNBC reported that the biggest banks are likely to face a capital surcharge of 2 to 2.5 percentage points rather than 3 points. The index fell 0.4 percent at 4 p.m. in New York after declining as much as 2.3 percent.

International central bankers and supervisors have decided banks need to hold more capital to avoid future taxpayer-funded bailouts. A proposed surcharge, previously reported to be 3 percent, may be lowered amid pushback from European nations, especially France, CNBC said without saying where it got the information. The amount may be set at a meeting in two weeks.

The Dodd-Frank Act, passed last July, gives the Fed new authority to control lending and risk-taking at the largest, most “systemically important” banks, following the government’s $700 billion financial-market rescue package in October 2008.

While the capital plans aren’t required under Dodd-Frank, “the Board believes that it is appropriate to hold large bank holding companies to an elevated capital planning standard because of the elevated risk posed to the financial system,” the Fed said.

Focus on Capital

The expansion of the reviews shows how the Fed and other regulators are focusing on capital as the most important buffer against risk. Financial stability isn’t the only objective, said Dino Kos, managing director at Hamiltonian Associates Ltd., New York. Regulators don’t want to ask Congress for another bailout, he said.

“Nobody in the regulatory apparatus ever wants to do that again,” said Kos, a former executive vice president at the New York Fed. The reviews should be extended to more banks because many need the discipline of looking at capital needs over longer time horizons, he said.

“Capital planning and stress testing is nothing new at M&T, it’s how we manage the bank, and we have a long and successful track record at it,” said Rene Jones, the Buffalo, New York-based firm’s chief financial officer, in an e-mail. “We had the lowest loan losses of any of the top 20 commercial banks through the financial crisis.”

Wendy D. Walker, a spokeswoman for Comerica, said the Dallas-based firm will study the Fed’s proposal.

“Huntington has routinely self-administered stress tests, and has continuously met or exceeded federal standards,” since the largest financial firms were subjected to stress tests in 2009, said Brent Wilder, a spokesman for the Columbus, Ohio- based firm.

Top 19 Banks

The Fed in 2009 ordered the top 19 U.S. banks to conduct so-called stress tests to ensure they could withstand a deeper economic slump. It later ordered 10 of them, including Charlotte, North Carolina-based Bank of America Corp. (BAC) and Atlanta-based SunTrust Banks Inc. (STI), to raise an extra $74.6 billion in capital. The results were released May 7 that year.

The more recent review, completed in March this year, also contained a stress test against scenarios involving a recession, a rise in unemployment and falling stock and housing prices. The test went beyond capital adequacy and forced bank boards to sign off on an explanation of how they would manage capital through a multiyear cycle of recession and recovery.

The Fed dedicated more than 100 staff to the March review, using a new multidisciplinary approach that enlisted economists, supervisors, and accounting experts in the analysis of financial institution risk.

Banks are dedicating more senior executives to the capital planning process and are getting into the habit of looking at capital through economic cycles, said a person familiar with the process. At the same time, Fed officials learned that the banks need to improve systems that pull loans, securities, and other risks together into formats that are easy to analyze and report to regulators, the person said.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net Steve Matthews in Atlanta at smatthews@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net